Tourism Management 32 (2011) 377e385

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Tourism Management
journal homepage: www.elsevier.com/locate/tourman

The impacts of international tourism demand on economic growth

of small economies dependent on tourism
Stefan Franz Schubert, Juan Gabriel Brida*, Wiston Adrián Risso
Competence Centre in Tourism Management and Tourism Economics (TOMTE), Free University of Bozen-Bolzano, School of Economics and Management,
Piazza Università 1, I-39100 Bolzano, Italy

a r t i c l e i n f o a b s t r a c t

Article history: This paper studies the impacts on economic growth of a small tourism-driven economy caused by an
Received 7 July 2009 increase in the growth rate of international tourism demand. We present a formal model and
Accepted 10 March 2010 empirical evidence. The ingredients of the dynamic model are a large population of intertemporally
optimizing agents and an AK technology representing tourism production. The model shows that an
Keywords: increase in the growth of tourism demand leads to transitional dynamics with gradually increasing
Tourism demand
economic growth and increasing terms of trade. In our empirical application, an econometric meth-
Economic growth
odology is applied to annual data of Antigua and Barbuda from 1970 to 2008. We perform a cointe-
Economic dynamics
VEC model
gration analysis to look for the existence of a long-run relationship among variables of economic
Antigua and Barbuda growth, international tourism earnings and the real exchange rate. The exercise confirms the theo-
retical findings.
Ó 2010 Elsevier Ltd. All rights reserved.

1. Introduction
International tourism is recognized to have a positive effect on
the increase of long-run economic growth through different
channels. First, tourism is a significant foreign exchange earner,
allowing to pay for imported capital goods or basic inputs used in
the production process. Second, tourism plays an important role in
spurring investments in new infrastructure and competition
between local firms and firms in other tourist countries. Third,
tourism stimulates other economic industries by direct, indirect
and induced effects. Fourth, tourism contributes to generate
employment and to increase income. Fifth, tourism can cause
positive exploitation of economies of scale in national firms (see
Andriotis, 2002; Croes, 2006; Fagance, 1999 and Lin & Liu, 2000).
Finally, tourism is an important factor of diffusion of technical
knowledge, stimulation of research and development, and accu-
mulation of human capital. These beliefs that tourism can promote
or cause long-run economic growth are known in the literature as
the Tourism Led Growth Hypothesis (TLGH). Tourism is the leading
source of foreign exchange in at least one of three developing
* Corresponding author.
E-mail addresses: stefanfranz.schubert@unibz.it (S.F. Schubert), juangabriel.
brida@unibz.it (J.G. Brida), wiston.risso@unibz.it (W.A. Risso).
countries that have made it a priority sector, and this holds
specially for small islands (see Durbarry, 2004). On the other hand,
it is important to note that a portion of the foreign exchange
generated by tourism is expatriated by Transnational Corporations,
through transfer pricing, and so on. This is true particularly for
small economies where most of the tourism industry is not owned
by residents.
There are several examples of small islands that depend
heavily on international tourism revenue and where the tourism
sector has received strong support from the government (see
Louca, 2006). The top 10 nations ranked according to the
contribution of tourism to GDP are all small islands (WTTC,
2008). Tourism has become a common development focus for
many countries, and a large quantity of small tropical island
economies reoriented their strategy of production from tradi-
tional export staples like sugar and bananas toward mass
tourism development, related construction and financial services.
It is not surprising that these microstates have chosen tourism as
the engine of development because they suffer many limitations.
These include lack of diversification because of resource scarcity,
income volatility because of extreme openness and export
concentration, small market size, and high transport costs.
Mihalic (2002) shows several advantages of tourism as a devel-
opment strategy compared to the export of goods and traditional
services. Some of these advantages are (a) natural and socio-
cultural attractiveness; (b) products produced locally can

0261-5177/$ e see front matter Ó 2010 Elsevier Ltd. All rights reserved.
doi:10.1016/j.tourman.2010.03.007
378 S.F. Schubert et al. / Tourism Management 32 (2011) 377e385
command a higher price sold locally to tourists than when
exported, and (c) some perishable goods can only be sold to
tourists in the domestic market.
As pointed out by Croes (2006), tourism provides advantages
in overcoming the smallness of a country in three ways. First, it
provides the volume to overcome insufficient market demand
enabling greater efficiency and providing economies of scale for
more goods and services which decreases the unit costs of
production. Second, it increases competition by encouraging new
entrants in the market place, which provides a positive impact
on the price level of goods and services. Third, tourism, by
providing scale and competition together with greater consumer
choice and trade openness, can raise the standard of living and
thus improve the quality of life in a small country. Some
empirical studies present strong evidence of a positive rela-
tionship between tourism and economic growth in small econ-
omies (see Durbarry, 2004 for Mauritius, Louca, 2006 for Cyprus,
Noriko & Mototsugu, 2007 for the Amami islands in Japan and
Vanegas & Croes, 2000, 2003 for Aruba). McElroy (2003, 2006)
present empirical evidence suggesting that successful tourism-
driven small islands represent a special insular development
case and an alternative to migration, remittances, aid and
bureaucracy.
Despite the arguments and beliefs presented in favor of the
important impacts of tourism on economic growth, there are very
few growth models including tourism as a sector and analyzing the
impacts of changes in tourism growth on long-run economic
growth. In this paper, we examine the impacts on economic growth
of a small tourism-driven economy caused by an increase in the
growth rate of international tourism demand. We present a formal
model and empirical evidence. Our model is a variant of the class of
tourism-led growth models, allowing for foreign borrowing on the
international financial market to finance investment and
consumption expenditures, and addresses the empirically impor-
tant issue of transitional dynamics. The ingredients of the dynamic
model are a large population of intertemporally optimizing agents
and an AK technology representing tourism production. The model
shows that an increase in the growth of tourism demand leads to
transitional dynamics with gradually increasing economic growth
and increasing terms of trade.
The empirical application of this paper uses the case study of
Antigua and Barbuda to test for the validity of the theoretical
findings. In our exercise, an econometric methodology is applied to
annual data from 1970 to 2008. We perform a cointegration anal-
ysis to look for the existence of a long-run relationship among
variables of economic growth, international tourism earnings and
the real exchange rate. The results support the main conclusions of
the theoretical model.
The rest of the paper is organized as follows. Section 2 provides
the dynamic model representing a small economy where tourism
is the main economic sector and describes the economic frame-
work. Section 3 describes the main properties of the equilibrium
of the model, and Section 4 discusses the economy’s steady state,
followed by a detailed analysis of an increase in the growth rate of
tourism demand. Section 5 describes the data and the econometric
methods used for estimation and presents the empirical results
and their interpretation. Some concluding remarks are made in
Section 6.
2. The model
The small open economy comprises a large number of identical
households and competitive firms, which are completely special-
ized in the production of tourism services. Households supply
a fixed amount of labor, l ¼ l, and consume an imported good.
Firms produce tourism services, T, using capital, K, and labor, l, as
factor inputs, using a simple AK technology; i.e., T ¼ AK.1 The
imported good can be used for consumption, C, and investment, I,
including installation costs, resulting in the investment cost func-
tion F(I, K). Both households and firms shall be represented by
a representative household and a representative firm, respectively.
The economy is small in the world financial markets, taking the
world interest rate r as given.2 However, tourism services produced
in the economy are different from tourism services supplied else-
where. Therefore, foreign demand Z for domestically produced
tourism services is a decreasing function of the relative price of
domestically produced tourism services in terms of the import
good, p, i.e., the terms of trade of the domestic economy. Further-
more, Z increases with foreign’s income, Y. For analytical purposes,
we assume the following iso-elastic tourism demand function3:
Z ¼ aY s p3
where s is the foreign income elasticity and 3 the price elasticity of
tourism demand, respectively4 and a represents a demand shift
parameter. Since the country is small, it cannot influence the rest of
the world’s income Y, but takes its evolution as given. World’s
income grows over time at the constant rate n according to
_
Y=Yhn. 5
Without loss of generality we can consolidate households
and firms into a representative consumereproducer, called repre-
sentative agent. The agent accumulates traded foreign bonds
(assets), B, denoted in terms of the imported good, that pay the
exogenously given world interest rate, r. The agent’s flow budget
constraint in terms of the foreign (imported) good is thus given by
B_ ¼ pAK  C  FðI; KÞ þ rB; (1a)
stating that the excess of income (pAK þ rB) over expenditure
(C þ F) is saved in the form of traded bonds. Since the domestic
economy is completely specialized in tourism production, both the
consumption good and physical capital must be imported from
abroad. Capital formation (investment) is associated with convex
1
The constant supply of labor of domestic households is contained in the A
expression. The AK technology can be justified by referring to the replication
argument. Of course, the use of more capital (hotels, resorts, etc.) will require more
labor, too. As domestic residents supply labor at a fixed quantity, increasing labor
demand will be met by employing foreign workers, as can be frequently observed in
reality. To keep the model as simple as possible, one can think K as being broadly
defined, including foreign labor supply. This too justifies assuming an AK tech-
nology. We also assume away externalities in production (which can also serve as
a justification of the AK model), because they are not relevant for the issue at hand.
For more on the AK technology, see, e.g., Turnovsky (2003).
2
While this assumption may not be reasonable for some developing countries, it
clearly holds for a region within a country, to which the model applies equally well.
3
To keep the model as simple as possible, we assume an iso-elastic tourism
demand function. Of course, such a function would have to be derived from the
utility maximizing behavior of tourists. However, assuming that tourists’ prefer-
ences can described by means of a Cobb-Douglas utility function, the demand for
tourism services would depend only on tourists’ income and the price of tourism
services, with unit elasticities with respect to income and the tourism price. To see
Q ai PN
this, let Uðxi ; .; xN Þ ¼ Ni ¼ 1 xi ; i ¼ 1 ai ¼ 1. The resulting demand function for
tourism, denoted as good number 1, x1 ¼ Z, would be Z ¼ (a1/p1)Y, that is, tourism
demand depends only on income and on the price p1 of tourism services. Our ad-
hoc formulation assumes a slightly different and more general form with constant,
but not necessarily unit income and price elasticities.
4
There is a lot of empirical evidence that the income elasticity of tourism
demand is well above unity (see, e.g., Syriopoulos, 1995 and Lanza, Temple, & Urga,
2003, reporting income elasticities in the range between 1.75 and 7.36), and that
the price elasticity is quite low (Lanza et al., 2003 derived price elasticities in the
range between 1.03 and 1.82). See also the comparison of different studies on
elasticities in Garin-Munos (2007).
5
Time derivatives will be denoted by dots above the variable concerned,
_
xhðdx=dtÞ.
 S.F. Schubert et al. / Tourism Management 32 (2011) 377e385 379

adjustment costs of the Hayashi (1982) type, expressed in terms of planned supply and demand functions are derived from optimiza-
the foreign good, i.e., tion behavior, the economy is continually in equilibrium, and all
  anticipated variables are correctly forecasted. We will call this
h I
FðI; KÞ ¼ I 1 þ (1b) concept a “perfect foresight equilibrium”.7 In particular, macro-
2K economic equilibrium requires the market for domestically
The linear homogeneity of the investment function in I and K is produced tourism services to be continuously cleared, that is
necessary to sustain an equilibrium of ongoing growth. Given the
depreciation rate d, which may be quite high as hotels and resorts AK ¼ aY s p3 (4)
require constant refurbishing, the change in the capital stock and what is guaranteed by proper adjustments of the relative price p.
investment are related by Combining (1c) and (3b), the capital stock evolves according to
K_ ¼ I  dK: (1c)
K_ q1 Y_ p_
¼ d ¼ s 3 (5)
The representative agent chooses the level of consumption of K h Y p
the imported good, C, the rates of investment, I, and of bond
where the second equality follows from goods market clearance (4).
accumulation, to maximize his intertemporal utility function
The equation can be solved for the rate of change in the relative
ZN price p. Thus, equations (5) and (3d) give the following equilibrium
1 g bt
Wh C e dt; N < g < 1; (2) dynamics for the relative price p and the market price of installed
g
0 capital, q:
 
subject to the constraints (1) and the historically given initial stocks p_ 1 q1
of capital K(0) ¼ K0 and traded bonds B(0) ¼ B0. The instantaneous ¼ sn þ d  (6a)
p 3 h
utility function is of the constant elasticity of substitution form,
with elasticity 1/(1g). b is the rate of consumer time preference,
taken to be constant. Performing the optimization6 gives rise to the q_ pA ðq  1Þ2
¼ rþd  (6b)
following optimality conditions: q q 2qh
_
where we have made use of the fact that Y=Yhn. System (6) implies
C g1 ¼ l (3a) constant steady-state values for p and q, hence the steady-state
growth rate of the capital stock is
I
1þh ¼ q (3b) ~_
K K
¼ sn
~
K
l_
b ¼ r (3c) Linearizing equations (6) around steady state, the values of
l which are denoted by tildes, and applying the transversality
pA q_ ðq  1Þ2 conditions8 gives the saddle-path stable solutions for the relative
þ þ d ¼ r (3d) price, p, and the market price of capital, q:9
q q 2qh
 
together with the transversality conditions ~ ¼
pðtÞ  p ~ em1 t
p0  p (7a)

lim lBebt lim lqKebt ¼ 0: (3e)  

t/N t/N A
~ ¼
qðtÞ  q ~ em1 t
p0  p (7b)
Equation (3a) equates the marginal utility of consumption of the r  sn  m1
imported good to the marginal utility of wealth in the form of foreign where m1 < 0 is the stable root of system. The stable saddle path
bonds. Equation (3b) gives rise to a Tobin q theory of investment. It follows thus as
equates the marginal cost of investment (new capital) to its market  
A
price, both expressed in terms of the foreign good. Equations (3c) and ~ ¼
qðtÞ  q ~
pðtÞ  p (8)
(3d) are dynamic no-arbitrage conditions. They equate the rates of r  sn  m1
return on consumption and of investment in capital to the rate of and is a positively sloped line in (p, q)-space. Finally, the growth
return on bonds, i.e., the interest rate. The rate of return on capital rate of the capital stock is given by
comprises four elements: The first is the dividend yield (marginal
value product of capital over its market price), the second the capital K_ A  
~ þ
hjK ¼ j ~ em1 t
p0  p (9)
gain, the third reflects the fact that an additional benefit of a higher K K
hðr  sn  m1 Þ
capital stock is to reduce the installation costs, which depend on (I/K),
with j ~ ¼ sn. Thus we have sgnðj  j ~ Þ ¼ sgnðp  p ~Þ. If the
associated with new investment, whereas the forth represents a loss K K K 0
due to the depreciating capital stock. initial relative price p0 falls below its steady-state level, the growth
rate of the capital stock during transition is lower than along the
steady-state balanced growth path.
3. Macroeconomic equilibrium

The macroeconomic equilibrium of this intertemporal general-

equilibrium model is defined to be a situation in which all the
6
The appendix contains additional material on derivations of the model’s
equations and dynamics.
7
See, e.g., Brock and Turnovsky (1981), p. 180.
8
Note that the transversality condition limt/NlqKebt ¼ 0 requires r > sn.
9
Note that because of goods market clearance (equation (4)) p(0) cannot change
upon a change in the growth rate of foreign income, which leaves the time t ¼ 0
level of demand constant. Hence, p(0) ¼ p0 is historically given. In contrast, the
market price of installed capital, q, is free to jump upon arrival of new information.
380 S.F. Schubert et al. / Tourism Management 32 (2011) 377e385

4. Analysis of an increase in foreign income growth capital stock’s (and thus tourism production’s) growth rate can be
derived from equation (9)
4.1. Steady-state changes
djK ð0Þ djT ð0Þ dj~ A ~
dp
K
¼ ¼ 
Since our model assumes perfect foresight, the dynamic evolution dn dn dn hðr  sn  m1 Þ dn
of the economy and hence the transitional adjustment is determined 1 sm
in part by agents’ expectations of the ultimate steady state. It is ¼  >0 (11c)
r  sn  m1
therefore convenient to start our analysis with the investigation of
the long-run steady-state effects of an increase in the growth rate of
_
foreign income, Y=Yhn. The balanced growth rate of the capital 4.3. Dynamic transition
stock (and thus of tourism production, j ~ ) changes according to
T
We now turn to the transitional dynamics of the economy. As
dj~ equation (9) reveals, the growth rate of the capital stock, although it
K
¼ s > 0: (10a) increases on impact, is lower than in the new steady state. Thus,
dn
higher foreign income growth transmits slowly to the economy.
Since the relative price of tourism remains constant in steady The time path of the growth rate of the capital stock, jK, is shown in
state, equation (6a) immediately gives the steady-state value of the Fig. 1. After its initial upward jump from point A to point B, it
market price of capital approaches the new balanced growth rate j ~ monotonically from
K

~ ¼ 1 þ hðsn þ dÞ below. Because the capital stock and thus production of tourism
q
services grow at a rate lower than the growth rate of demand
Hence, the steady-state change of q is induced by foreign income growth (jK(t) ¼ jT(t) < sn), goods
market clearance requires the price of tourism services and thus the
~
dq terms of trade to increase over time to maintain tourism demand
¼ hs > 0 (10b)
dn on the level of tourism production. As p rises over time, the value of
Differentiating the no-arbitrage condition (3d) at steady state, the marginal product of capital in terms of the foreign good, pA,
using (10b), the steady-state change of the relative price of tourism increases, making capital more attractive and thus raising its
immediately follows as market price q and hence investment expenditures, speeding up
the growth rate of the capital stock and hence of tourism produc-
~
dp hs tion. These dynamic adjustments are illustrated in Fig. 2. At time 0,
¼ ðr  snÞ > 0 (10c) when n rises, the market price of installed capital, q, jumps from the
dn A
original steady state, point C, up to point D, located on the new
The intuition about these steady-state changes is straightfor-
saddle-path SS. From thereon, the economy moves along SS, with
ward: In steady state, prices remain constant over time. Thus, an
gradually increasing prices q and p. Eventually, the small island
increase in tourism demand growth leads to an equal increase in
economy settles down at the new steady state, point E, where all
steady-state tourism production growth, requiring an equal
transitional adjustments are completed and the economy grows
increase in the balanced growth rate of the capital stock, too, ~ ¼ sn along its balanced growth path. Therefore,
with rate j K
because jT ¼ jK. In turn, a faster growing capital stock requires an
a booming tourism demand will lead to transitional dynamics,
increase in the market price of installed capital, q ~. Finally,
where higher production growth is accompanied by price increases
a permanently booming tourism demand leads to a higher relative
(terms of trade improvements), as one can observe in reality.
price p~ of tourism production, i.e., to an improvement of the
economy’s terms of trade. The reason can be found in the transi-
5. Empirical evidence
tional dynamics and is described below.
In the present section we present an empirical approach to test
the previous model. In our case study, Antigua and Barbuda can be
4.2. Impact effects
taken as a representative small island economy that is tourism
driven. In this country more that 75% of the gross domestic product
Having described the long-run effects of higher tourism demand
growth, we turn to the short-run (impact) effects. Since the capital
stock K0 is historically given and the level of Y does not change on
impact, the initial effect on tourism production as well as on the
price of tourism is zero:

dTð0Þ dKð0Þ dpð0Þ

¼ ¼ ¼ 0 (11a)
dn dn dn
But the expectation of a higher long-run price of tourism
services increases the expected future dividend yield, resulting in
an increase in the market price of installed capital, as for investors
the capital stock becomes more valuable. This can be seen by
differentiating equation (7b) at time 0, inserting the steady-state
changes and simplifying

dqð0Þ ~
dq A ~
dp
¼  ¼ m1 hs > 0 (11b)
dn dn r  sn  m1 dn
Note that this initial reaction is entirely forward-looking, as it
depends on the new steady state of the economy. The impact on the Fig. 1. Growth rate of capital stock.
 S.F. Schubert et al. / Tourism Management 32 (2011) 377e385 381

Table 1
Unit root test results: levels.

Variable y y* RER

Unit root test ADF KPSS ADF KPSS ADF KPSS

Trend, Constant 1.46 0.14 4.51a 0.04 1.59 0.12
Constant 0.52 0.76a 0.18 0.76a 1.57 0.62a
Without Trend, Const. 2.81a 9.39 2.13a
a
Null Hypothesis Rejection at 5%.

GDP is due to tourism, and the country ranks first in tourisms’

Fig. 2. Dynamics of p and q.
GDP is due to tourism. Antigua and Barbuda is a very small country
of 443 sq. km with a population of 76,500 inhabitants. The island is
an open economy in which external trade in goods and services
comprises a major portion of its economic activity. Within the
Eastern Caribbean, the tourist industry in Antigua and Barbuda is
one of the earliest that was developed, and it is now ranked among
the largest. The geographical position of the island makes it a stra-
tegic stop for aircraft and pleasure yachts crossing the Atlantic. The
country is one the more popular ports of call for cruise vessels. The
comparatively flat terrain of the island allows for tours and visits to
the various attractions and sites to be completed within the normal
shore time for the cruise passengers. Tourism is the largest
economic sector in Antigua and Barbuda. Notice that, according to
WTTC (2009), Antigua and Barbuda takes the first position in the
world ranking about the relative contribution of tourism in national
economies. Tourisms’ contribution to overall economic activity is
about 70% of total GDP, several times larger than agriculture and
manufacturing. The tourist sector is the largest earner of foreign
exchange in Antigua and Barbuda and is estimated to be the largest
employer when all enterprises providing direct and indirect
services to the sector are combined, with approximately 11,000 jobs
or about 42% of the total. The greatest impact of tourism is on
commerce, as is evidenced by the size of the Wholesale & Retail
Trade sector. The purchase of goods and services by tourism
establishments and the visitor population has generated a level of
imports that is out of proportion with the demands of the domestic
population. This has given rise to the establishment of a wide range
of general and specialty enterprises supplying goods and services to
the accommodation sector and directly to the visitor population.
The dominant position of tourism in the economy makes Antigua
and Barbuda heavily dependent on international arrivals. Weak
tourist arrival numbers since early 2000 have slowed the economy
and pressed the government to find solutions.
5.1. Econometric methodology and dataset
contribution to GDP.
2) Real GDP of USA. The real GDP of USA (y*) is used as a proxy of
GDP of the rest of the world (represented by Y in the model).
This is motivated by the fact most of tourists arriving to the
country are from USA. Furthermore, the USA are the largest
economy in the world, heavily influencing other countries’ GDP
via international interdependencies.
3) Real exchange rate. The relative price of tourism (p) is proxied
by the real exchange rate (RER). The motivation of this choice is
justified by two facts. First, it was not possible to obtain a long
time series for the price of tourism in the island. Second, in the
case of Antigua and Barbuda, more than 75% of total production
is represented by tourism, implying the relative price of
tourism comes close to the RER.
We introduce a cointegration analysis to study the existence of
a long-run relationship among the three variables and a Vector
Error Correction (VEC) model to characterize the short-run
dynamics. Let Yt h (yt, y*t , RERt) be the vector of the relevant vari-
ables. The model is represented by a first-differenced error
correction form as shown in equation (12):
X
i¼ k1
DYt ¼ m þ PYt1 þ Gi DYti þ 3t (12)
i¼1
where Yt is a column vector of the variables, D is the first difference
operator, m is a vector of constant terms, G and P are the coefficient
matrices, k denotes the lag length and 3t is the residual vector. The
matrix P conveys information about the long-run relationship
between the Y variables. In the absence of a cointegrating vector, P is
a singular matrix, which means that the cointegrating vector rank is
equal to zero. On the other hand, in a cointegrated scenario, the rank
of P could be anywhere between zero and full rank. In other words,
the Johansen cointegration test can determine the number of coin-
tegrating equations, and this number is named the cointegrating
rank. The rank of P is the number of linearly independent and
stationary linear combinations of the variables studied. We start
with the cointegration analysis, and in case of a negative result, we
apply a Vector Autoregressive model (VAR) to the variables in levels
(if they are stationary) or in differences (if the levels present a unit
root). The first step is the introduction of a unit root test to study the
stationarity of the series. In case of being non-stationary we can
apply the Johansen cointegration test to detect long-run relation-
ships in data. Besides, weakly exogeneity is tested in the model, and

Well-known econometric tools applied to model long-run and

Table 2
short-run dynamics are the cointegration methodology and the
Unit root test results: first difference.
vector error correction model (VECM). In this section we study the
causal relationship among three variables: Variable dy dya dRER
Unit root test ADF KPSS ADF KPSS ADF KPSS
1) Real GDP of Antigua and Barbuda. Since the theoretical model Trend, Constant 4.842a 0.08 5.03a 0.50a 2.34 0.14
explains the determinants of economic growth in small econ- Constant 4.90a 0.10 5.10a 0.50a 2.20 0.16
omies based on tourism, we use the real GDP of Antigua and Without Trend, Const. 2.17a 2.15a 1.59
a
Barbuda (y). WTTC (2009) asserts that more than 75% of the Null hypothesis is Rejection at 5%.
382 S.F. Schubert et al. / Tourism Management 32 (2011) 377e385

Table 3 KPSS test. The null hypothesis in the case of the ADF test is that
Unrestricted cointegration rank test. the process is integrated I(1), and it is accepted unless there is
Trend assumption: No deterministic trend strong evidence against it. On the other hand, the null hypothesis
Series: y, y*, RER in the case of the KPSS test is stationarity, complementing the
Hypothesized No. of CE Eigenvalue Trace Stat. Critical value Prob. ADF test which has low power against stationary near unit root
Trace processes. Therefore, a stationary process rejects the null
Nonea 0.48 39.83 35.19 0.01 hypothesis for ADF but it does not in the case of the KPSS test.
At most 1 0.29 16.85 20.26 0.13 Tables 1 and 2 show unit root tests for the logarithm of the
At most 2 0.12 4.70 9.16 0.32
variables in levels and in differences.
Maximum eigenvalue Note that Tables 1 and 2 indicate that GDP of the USA and
Nonea 0.48 22.98 22.30 0.04 Antigua and Barbuda are integrated processes of first order. The
At most 1 0.29 12.15 15.89 0.18
results for the RER are not that clear. The ADF test indicates that
At most 2 0.13 4.70 9.16 0.32
RER is I(2) which means that the rate of change in RER would
Trace and max. eigen. test indicates 1 cointegrating eqn(s) at the 0.05 level.
a
increase with time, however, the KPSS should indicate that the
Denotes rejection of the hypothesis at the 0.05 level.
process is stationary in differences. Since the ADF tends to accept
the unit root hypothesis most of the time, we can deduce that RER
the Granger causality test is applied to analyze causality between the is I(1) as y and y*. Hence classical econometrics is not applied, and
variables. Finally, we estimate the VECM model. Data for Antigua and we have to study the existence of a cointegrating relationship. One
Barbuda was obtained from different sources. The real historical GDP method is the two-step procedure proposed by Engle and Granger
of Antigua and Barbuda (y) and USA (y*) in billions of 2005 dollars for (1987). However, this method assumes the existence of only one
the period 1970e2008 were obtained from World Bank World cointegrating relation. A more general procedure was proposed by
Development Indicators, International Financial Statistics of the IMF, Johansen (1988) and Johansen and Juselius (1990). Their test has
Global Insight, and Oxford Economic Forecasting, as well as esti- the advantage of testing all the possible cointegrating relation-
mated and projected values developed by the Economic Research ships. Banerjee, Dolado, Galbraith, and Hendry (1993) highlight
Service, all converted to a 2005 base year. The real exchange rate the important connection between a cointegration relationship
(RER) was obtained from ERS International Macroeconomic Data and the corresponding long-run equilibrium equation. Searching
Set. (http://www.ers.usda.gov/Data/macroeconomics). for a cointegration relation is searching for a statistical equilib-
rium between variables tending to grow over time. Table 3 indi-
5.2. Results cates that there is a unique long-run relationship among the
variables.
Most of the time, when we work with economic time series, To do inference we should at least check weak exogeneity.
the regressions we obtain produce significant OLS parameter Existence of weak exogeneity permits us to use the estimated
estimates, and a high R-square. However, the residuals are non- equation without modeling the variable that we do not consider to
stationary, thus violating the standard assumption of classical be endogenous to the model. According to the LR test with 2
econometrics. This problem is known as spurious regression. restrictions, the variables y* and RER can be considered as weakly
Phillips (1986) remarked that in this case cointegration tech- exogenous, the statistic c2(2)is 8.19 and the p-value is 0.02.
niques have to be applied. The first step in cointegration analysis Equation (13) shows the long-run equilibrium or cointegrating
is to study the integration order of the series by using a unit root equation after testing weak exogeneity, t-statistics are presented
test, such as the Augmented DickeyeFuller test (ADF) and the in brackets.

Fig. 3. Impulse response to an increase in the GDP of USA (y*). a) the effect over y; b) the effect over y*; c) the effect over the RER.
 S.F. Schubert et al. / Tourism Management 32 (2011) 377e385
32:93 þ3:59y*t 0:24RERt
yt ¼ (13)
½4:03 ½  4:02 ½2:29
The elasticity of real GDP with respect to y* is 3.59. This means
that, ceteris paribus, an increase in the real GDP of the USA by 1%
produces (in the long-run) an increment of 3.59% of the real GDP of
Antigua and Barbuda. The Vector Error Correction Model (VECM) is
given by the following system of equations:
 
Dyt ¼ 0:09 yt  1  3:59y*t1 þ 0:24RERt1 þ 32:93  0:04Dyt1  0:27Dyt2  0:15Dyt3 þ 0:27Dy*t1
0:01Dy*t2  0:22Dy*t3 þ 0:10DRERt1  0:001DRERt2 þ 0:04DRERt3 ;
Dy*t ¼ þ0:19Dyt1  0:03Dyt2  0:09Dyt3 þ 0:26Dy*t1  0:12Dy*t2  0:05Dy*t3 þ 0:01DRERt1
þ 0:03DRERt2 þ 0:01DRERt3 ;
DRERt ¼ þ0:59Dyt1 þ 0:91Dyt2  0:02Dyt3  1:14Dy*t1 þ 0:33Dy*t2  1:16Dy*t3 þ 0:93DRERt1
 0:40DRERt2 þ 0:25DRERt3 ;
This model is employed to examine the impact produced by
a shock in the variable GDP of the USA (y*) on the other variables of
the model after a period of 100 years. Fig. 3 shows the effects on y,
y* and RER, respectively.
Note that a positive shock on the GDP of USA has a positive effect
on all the variables, passing from an equilibrium to another one
with larger values. These results confirm the main results of the
model developed in the previous sections.
6. Summary and conclusions
In this paper we studied the effects of an increase in foreign
income growth, translating into an increase in the growth rate of
tourism demand, on economic key variables of a small island
economy that is completely specialized in the production of tourism
services by means of an AK technology. We found that an increase in
the growth rate of foreign income initiates transitional dynamics, as
the economy cannot (i) immediately move along its new balanced
growth path and (ii) be isolated from the rest of the world’s devel-
opments via proper price adjustments. The increase in foreign
income growth, leading to a boom in tourism demand, is met by
a higher rate of capital accumulation and thus tourism production
and a gradually increasing price of tourism services (i.e., the terms of
trade), to keep demand in line with supply. The increasing price of
tourism services makes investments into tourism production more
attractive, speeding thus up its growth rate. Hence, as time passes,
the island economy experiences a phase of increasing growth.
Eventually, the economy reaches its new balanced growth path,
where prices remain constant and the economy’s growth rate is
proportional to the foreign growth rate. Despite the simplicity of the
model, it highlights the dynamic effects and the transmission of
changes in growth abroad and replicates some stylized facts. It thus
can serve as a starting point for more sophisticated models, in which
e.g., a second (industrial) sector may be added to the tourism sector.
Empirical results for the case of Antigua and Barbuda confirm
the theoretical findings. The cointegration analyses confirm the
hypothesis of a positive relationship linking real per capita GDP of
Antigua and Barbuda, real per capita GDP of the USA and the
relative price between the two countries. In addition, we show that
y* and RER are weakly exogenous, and the Granger causality test
suggests that causality is from international tourism demand to per
capita GDP of Antigua and Barbuda. The elasticity of the GDP per
capita with respect to y* is 3.59 percentage points, which means
383
that, ceteris paribus, an increase of 1% in per capita GDP of USA
produces, in the long-run, an increase of 3.59% in GDP per capita of
Antigua and Barbuda. This result is in line with previous studies for
small tourism-driven economies and confirms the hypothesis of
tourism as the engine for economic growth. It has to be pointed out
that there are some limitations of our study. First, note that the
results of the paper would only be applicable if the tourism sector
contributes significantly to GDP as in the case of Antigua and Bar-
buda. We cannot generalize the conclusions to other types of
economies. Second, our model is premised on the general equilib-
rium postulates of no frictions in the market, continuous market
clearance, and the existence of complete feedback. The tourism
market is plenty of imperfections and distortions generated by
externalities and public goods, thereby rendering simple general-
equilibrium representations as problematic. Future research could
concentrate in introducing some of these points in our model,
augmenting thus the general-equilibrium framework we applied.
Acknowledgements
Our research was supported by the Free University of Bolzano,
project: “Tourism, growth, development and sustainability. The
case of the South Tyrolean region”. The constructive comments of
three anonymous referees and the editor, Chris Ryan, are gratefully
acknowledged.
Appendix
A1. First order conditions
To obtain the first order conditions (3) in the main text, we have
to solve the dynamic optimization problem contained in equations
(1) and (2). Such a dynamic problem can be solved by applying
Pontryagin’s maximum principle. Hence, we define the Hamilto-
nian function
1
Hh C g þ lðpAK  C  FðI; KÞ þ rBÞ þ zðI  dKÞ
g
which comprises the function to be maximized and the two
dynamic constraints (1a) and (1c). l is the shadow value of wealth
in the form of traded foreign bonds and can be interpreted as the
marginal utility of wealth in the form of traded bonds, and z
measures the shadow value of capital. The first order conditions for
the dynamic optimization problem are vH/vC ¼ 0, vH/vI ¼ 0 and
l_  bl ¼ vH=vB; z_  bz ¼ vH=vK. The first two equations are
static optimality conditions, whereas the third and the forth
equation represent dynamic optimality conditions. Calculating the
partial derivatives of H and applying the static optimality condi-
tions gives rise to
C g1  l ¼ 0 (A1)
384 S.F. Schubert et al. / Tourism Management 32 (2011) 377e385

  !!
I ~1
q    
l 1 þ h þz ¼ 0 (A2) q_ ¼ rþd ~ A pp
qq ~
K h
Rearranging (A1) and (A2) and defining qhz=l as the market
~  1Þ=h ¼ sn (see (A5)), we
Noting that at steady state d  ðq
price of installed capital results in equations (3a) and (3b) in the
obtain
text. The dynamic optimality conditions read
   
~ A pp
q_ ¼ ðr  snÞ q  q ~
l_  bl ¼ lr (A3)
(A6a)

 2 ! Turning to the market price, we get

_z  bz ¼  lpA þ lh I zd (A4) !
2 K ~ 
p  1 ~1 
q 
p_ ¼  ~ þ
qq sn þ d  ~
pp
(A3) leads immediately to equation (3c) in the text, whereas (A4) 3h 3 h
has to be manipulated in the following way: Using the definition
~  1Þ=h (see (A5)),
Recognizing that at steady state sn þ d ¼ ðq
of q, we get z ¼ ql and, taking time derivatives, z_ ¼ q_ l þ ql_ .
Substituting for z and z_ , (A4) becomes we are left with
!
 
h I 2 ~ 
p 
_ql þ ql_  bql ¼  lpA þ l qld p_ ¼  ~
qq (A6b)
2 K 3h
(A6a) and (A6b) can be written compactly in matrix form:
Dividing by l results in
  ! !
 2 q_ ðr  snÞ A ~
qq
l_ h I ¼ ~ (A7)
q_ þ q  bq ¼ pA  þqd p_  3ph 0 ~
pp
l 2 K
Substituting from equation (A3) for l_ and dividing by q, noting The determinant of the matrix in (A7) reads Ap ~=ð3hÞ < 0 and is
that from (3b) we have (I/K)2 ¼ (q1)2/h2, and rearranging finally thus negative. Therefore, the dynamic system (A7) has one negative
gives and one positive eigenvalue, denoted by m1 < 0 and m2 > 0, and is
thus saddle-path stable. The eigenvalues satisfy m1 þ m2 ¼
pA q_ ðq  1Þ2 r  sn > 0.10 The stable root m1 is the economy’s speed of conver-
þ þ d ¼ r (A4’)
q q 2qh gence during a stable transition to steady state. The eigenvectors u1
and u2 of (A7) are
which is (3d) in the text. The transversality conditions (3e) rule out
 A
  A

Ponzi schemes by requiring that asymptotically the value of bonds
lB and the value of capital lqK must not grow at a rate higher than u1 ¼ rsnm1 ; u2 ¼ rsnm2
1 1
the discount rate b.
Therefore, the general solution of system (A7) is
A2. Equilibrium dynamics ( )    
~
qq A A
¼ X1 rsnm1 em1 t þ X2 rsnm2 em2 t (A8)
The equilibrium dynamics of the capital stock follow from (1c) ~
pp 1 1
and (3b) as
where X1 and X2 are arbitrary constants to be determined now.
K_ I q1 Because m2 > 0, to approach the steady state we require X2 ¼ 0.
¼ d ¼ d Because of goods market clearance (4), p has to move continuously,
K K h
whereas q is free to jump upon arrival of new information. Thus,
Rewriting goods market clearance (see (4)) in growth rates ~ ¼ X1 . The stable
starting at time 0 from p(0) ¼ p0, we have p0  p
implies
solution of system (A7) is thus
( )  
K_ Y_ p_ ~
qq A
¼ s 3 ¼ ðp0  pÞ rsnm1 em1 t (A9)
K Y p ~
pp 1
Hence, the capital stock evolves according to
which are equations (7a) and (7b) in the text. The equation for the
K_ q1 Y_ p_ saddle path (8) follows immediately by substituting (7a) into (7b).
¼ d ¼ s 3 (A5)
K h Y p After the increase in n, The system moves immediately onto the
stable saddle path by a proper jump of q(0).
_
Denoting the growth rate of foreign income Y=Yhn, (A5) can be The growth rate of the capital stock is obtained by inserting the
_
solved for p=p, which gives (6a) in the text. Equation (6b) in the text stable solution (7b) into (5):
_
is simply equation (A4’) solved for q=q. Because in steady state the
   
_
growth rate of capital K=K has to remain constant by definition, q K_ 1 A
hjK ¼ p0  p ~1 d
~ em1 t þ q
has to remain constant in steady state, too, and this is, see (A4’), K h r  sn  m1
only possible if p is constant in steady state. This proves the
statement made in the text. ~  1 ¼ ðsn þ dÞh (see (A5)), this
Noting that at steady state q
becomes
A3. Linearized dynamics

Equations (6a) and (6b) have to be linearized around the steady

state ðq ~ This task is accomplished by a first order Taylor
~; kÞ. 10
This follows from the fact that m1 þ m2 equals the trace of the matrix in (A7), which
expansion of (6a) and (6b) around steady state: is rsn. Note that the transversality condition limt/NlqKebt ¼ 0 requires r > sn.
 S.F. Schubert et al. / Tourism Management 32 (2011) 377e385 385

    Croes, R. R. (2006). A paradigm shift to a new strategy for small island economies:
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h r  sn  m1 economic stability. Tourism Management, 27, 453e465.
Because the steady-state growth rate of the capital stock is Durbarry, R. (2004). Tourism and economic growth: the case of Mauritius. Tourism
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q Lanza, A., Temple, P., & Urga, G. (2003). The implications of tourism specialisation in
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Geografiska Annaler, 85(4), 231e242.
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Mihalic, T. (2002). Tourism and economic development issues. In R. Sharply, &
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dn A dn A dn Noriko, I., & Mototsugu, F. (2007). Impacts of tourism and fiscal expenditure to
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